Death and Taxes: Executors Beware

The Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act of 2010 (2010
Tax Relief Act), P.L. 111-312, was signed by
President Barack Obama on December 17, 2010, and
revised tax law for estates of decedents dying in
2010, 2011, or 2012. The pre-2001 rules will be
reinstated for deaths starting in 2013 unless
Congress acts again before 2013. The new rules apply
for 2010 unless an executor elects to use prior law.
This election is made on Form 8939, Allocation of
Increase in Basis for Property Acquired from a
Decedent. However, the IRS has not yet released a
final version of Form 8939. Elections for 2010
decedents can be made at a time not less than nine
months from December 17, 2010, so estates of
decedents dying in early 2010 can still be made
timely.

The 2010 Tax Relief Act provides a $5
million estate tax exemption (indexed for inflation
after 2011), a step-up in basis to market value, a
top rate of 35% on taxable transfers (Sec. 2001(c),
as amended by the 2010 Tax Relief Act, §302(a)(2)),
and portability of unused exemptions between spouses
for 2011 and 2012. Portability allows the estate of
the second spouse to die to claim the unused
exemption not claimed by the estate of the first
spouse to die if
the executor of the first-to-die spouse makes
a timely election on the estate tax return of the
first-to-die spouse. This effectively creates a $10
million exemption for married couples.

The
2010 Tax Relief Act also increased the lifetime gift
tax exemption to $5 million starting in 2011. The
generation-skipping transfer (GST) tax was
reinstated, but the rate is zero for transfers in
2010, with a $1 million exemption. The GST tax is
reunified with the gift tax ($5 million exemption)
for 2011 and 2012.

The election in the 2010
Tax Relief Act to apply prior law may create traps
for executors and affect beneficiaries, so
understanding the election and preparing scenarios
for 2010 deaths using old and new law is critical
post-death planning. Some commentators believe that
executors (and tax return preparers) may face
litigation if the election decision adversely
affects some classes of beneficiaries and their
interests are not fully considered (and possibly
should even compensate those heirs hit with higher
income taxes that will result if an election is made
to use the old law modified carryover basis instead
of the new law step-up to fair market value
(FMV)).

The old law was the Economic Growth and
Tax Relief Reconciliation Act of 2001 (EGTRRA), P.L.
107-16, which repealed the estate tax for decedents
dying after December 31, 2009, but before January 1,
2011. For 2010, estates were allowed to pay no
estate tax, but assets in the estate did not receive
a step-up in basis to FMV at the date of death or
alternate valuation date (Sec. 1022, as amended by
EGTRRA, §542). The basis in heirs’ assets was to be
determined under the modified carryover basis rules
under Sec. 1022, treating property as acquired by
gift, with basis being the lower of the decedent’s
adjusted basis at date of death or FMV at death.
Basis was subject to a special allocation of
$1,300,000 (increased for unrealized losses and
unused capital losses and net operating loss
carryovers not exceeding FMV at death) plus an
additional allocation of $3 million if distributed
to a spouse (see also Joint Committee on Taxation,
Technical
Explanation of the Revenue Provisions Contained in
the “Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act of
2010” (JCX-55-10), p. 42 (December 10,
2010)).

We do not yet know whether Congress
will apply pre-EGTRRA rules ($1 million exemption,
55% rate) for deaths after 2012 or make further
changes before 2013. This makes planning highly
complex and perhaps further complicates it if there
is a first-to-die spouse in 2010. However, if the
increase to a $5 million exemption and portability
between spouses of the exemption becomes permanent,
fewer people may need estate planning and may rely
on the exemptions to cover their needs.

For
deaths in 2010, the new rules apply unless an
executor elects to have the EGTRRA rules apply,
which provide for no estate tax and modified
carryover basis. The due date for filing an estate
tax return, paying the estate tax, and making any
disclaimer of assets will be not earlier than nine
months after December 17, 2010 (2010 Tax Relief Act,
§301(d)(1); Sec. 6075). Therefore, executors may be
called upon to justify their choice of whether to
use the old rules or the new rules by some classes
of heirs, leading to possible litigation if the
parties are negatively affected. The election will
in some cases result in a lower estate tax but
create income tax burdens for selected beneficiaries
by using modified carryover basis.

For
example, depending on the terms of the will, estate
taxes may be paid from the residuary estate and not
burden specific bequests. If an election is made to
use the old rules and pay no estate tax, which
benefits residuary beneficiaries, while giving up a
step-up in basis, that election may negatively
affect beneficiaries of specific bequests who get a
lower basis in assets received and higher income tax
if the asset is sold.

Similar issues may
arise when the executor is called upon to make the
special basis adjustments and one group of
beneficiaries is favored over another. Will those
affected have a cause against the executor and other
tax planners? If the estate tax was to be paid by
residuary beneficiaries, has the recipient or a
specific beneficiary been injured? Will executors
who are also beneficiaries have a conflict of
interest when deciding whether to elect the old law
or the new law?

There are other examples
where the interests of parties could be affected by
making the election. If the decedent is a
first-to-die spouse with a well-written document
leaving assets to a bypass trust and the surviving
spouse, no immediate estate tax is due. What if the
estate is asset rich, cash poor, but valued over $10
million? If the surviving spouse wants to convert
assets to cash to pay estate tax upon his or her
death, a step-up in basis may in some cases be the
best choice to allow asset sales with little or no
income tax while providing cash to pay the
second-to-die estate tax. The tax planner would have
to run the numbers using various scenarios.

Some commentators have suggested that executors
air the issue with beneficiaries and even request a
court determination before deciding whether to make
the election. Accountants advising executors or
preparing estate tax filings might well request some
indemnification or make clear that this decision is
made by the estate with an understanding of the
impact on various classes of beneficiaries.

EditorNotes

Valrie Chambers is a professor of accounting at
Texas A&M University–Corpus Christi in Corpus
Christi, TX. Joseph Brophy is with Joseph D. Brophy,
CPA, P.C., in Dallas, TX. They are both members of
the AICPA Tax Division’s IRS Practice and Procedures
Committee. For more information about this column,
contact Prof. Chambers at valrie.chambers@tamucc.edu.

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”

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